European Bond Traders Counting on Draghi to Keep Dovish Message

  • Key inflation gauge for region touches highest since January
  • U.S.-German spread last week reached widest since 1989

Bad News Is Priced Into the Euro, Says Chaigneau

European bond investors are counting on Mario Draghi to safeguard the trend toward higher inflation expectations and cap declines in the region’s sovereign-debt securities.

Benchmark German 10-year bunds held a four-day advance before the European Central Bank president addresses lawmakers in Strasbourg, where he may stress officials’ commitment to providing monetary support. While traders across the Atlantic are preparing for higher interest rates from the Federal Reserve next month, the debate in Europe is about whether the ECB’s public-sector purchase program will be tweaked and expanded beyond March.

While a key gauge of investors’ inflation expectations has jumped to its highest since January in the wake of the U.S. election, it still signals that the ECB is not on track to meet its annual inflation goal of just below 2 percent. The diverging inflation and policy outlook with the U.S. last week pushed the extra yield, or spread, that investors get for holding Treasury 10-year notes instead of German bunds to the most since 1989.

“It’s now more or less clear that the Fed is going to hike in December, but on the other hand, it looks like the ECB will definitely continue with PSPP beyond March 2017 as inflation is still well below target,” said Daniel Lenz, a market strategist at DZ Bank AG in Frankfurt. “Draghi has to make clear that the ECB won’t change its policy just because of the U.S. election outcome and a possible Fed rate hike in December.”

Germany’s 10-year bund yield was little changed at 0.27 percent as of 4:02 p.m. London time. The price of the zero percent security due in August 2026 was 97.406 percent of face value. The yield has dropped from as high as 0.4 percent on Nov. 14, which was the most since January.

The five-year, five-year forward inflation swap rate, a rolling gauge of inflation expectations in the euro region, was at 1.61 percent, the highest since Jan. 13 based on closing prices.

Treasuries advanced Monday, narrowing the yield spread with 10-year bunds to 205 basis points, after surging last week to 208 basis points.

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